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Shutterfly Inc. (SFLY - Analyst Report) has reported second-quarter 2012 loss of 27 cents per share, substantially beating the Zacks Consensus Estimate of loss of 35 cents per share but wider than the previous-year loss of 11 cents.

In the quarter under review, net revenue increased 31% year over year to $99.0 million which was significantly ahead of the Zacks Consensus Estimate of $91.0 million, induced by the sturdy sales from the Consumer category.

The Consumer category received a boost from the selling of core products like photo books, calendars and cards during gift-giving ceremonies like Easter, Mother's Day, Father's Day and graduation, as well as sustained growth in the Enterprise business.

Behind the Headline Numbers

Revenues from the Consumers’ category were $94.4 million in the quarter, up 29% over the prior-year quarter. Net Enterprise revenues witnessed a significant improvement from $2.7 million in the year-ago quarter to $5.0 million in this quarter.

The total number of customers was 1.9 million in the quarter, reflecting an increase of 14% from the prior-year quarter. Total orders generated were 3.0 million, up 15% year over year. Average order value was $31.70, up 5% year over year.

Gross profit margin expanded 140 basis points to 48.8% from the prior-year quarter driven by higher material, labor and shipping margins stemmed from sales leverage, and increased proportion of higher-margin greeting cards. However, the addition of Tiny Prints’ customer service, along with outsourced manufacturing costs and steeper markdown in some products provided a partial offset.

Liquidity

Shutterfly exited the quarter with cash and cash equivalents of $118.1 million, compared with $179.9 million at the end of December 2011. The total shareholders’ equity remains around $632.2 million in the reported quarter versus $609.0 million at the end of December 2011.

Outlook

For the third quarter of 2012, Shutterfly expects net revenue in the range of $89.5 million to $91.5 million. The company expects GAAP diluted net loss of 44 cents to 41 cents per share.

For fiscal 2012, Shutterfly expects net revenue to range between $582—$592 million ($576—$586 million predicted earlier). In the preceding quarter as well, management had boosted its full-year revenue guidance from a range of $550—$560 million to $576—$586 million.

On a GAAP basis, earnings are estimated to be in between 11 cents and 21 cents per share (7 cents and 16 cents estimated previously). While management slashed the full-year earnings per share guidance from 25—28 cents to 7–16 cents in the last quarter, it raised the same to 11 cents and 21 cents this time.

Our Take

Shutterfly is panning out with initiatives like product innovation, strategic partnerships with retailers and persistent opportunistic acquisitions. Some of Shutterfly’s recently clinched deals like takeover of Kodak Gallery online photo services and Photoccino will likely prove to be beneficial for the company over the long-term. Management sees several opportunities ahead as the social expression and personal publishing markets are still blooming.

However, challenging economic conditions as well as competitive pressures pose a threat to the company’s margin expansion.  Shutterfly Inc. competes with companies like LookSmart Ltd. , Snapfish owned by Hewlett-Packard Co. (HPQ - Analyst Report) and Photoworks and Webshots brands of American Greetings Corp.

Additionally, the upcoming quarter is seasonally weak due to the absence of any ‘gift-giving’ occasions. The company also remains vigilant about increasing its investments in order to improve infrastructure in the latter half of the year which could suppress earnings.

Shutterfly currently retains a Zacks #2 Rank, which translates into a short-term Buy rating. We are also maintaining our long-term Neutral recommendation on the stock.

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